Building Societies Association

SUBMISSION FROM THE BUILDING SOCIETIES ASSOCIATION Introduction 1. The Building Societies Association (BSA) represents mutual lenders and deposit takers in the UK, including all 52 UK building societies. Building societies (as at the end of July 2009) have total assets of over £370 billion and, together with their subsidiaries, hold residential mortgages of over £245 billion, more than 20% of the total outstanding in the UK. Societies hold nearly £240 billion of retail deposits, accounting for more than 20% of all such deposits in the UK. Building societies also account for about 36% of all cash ISA balances. Building societies employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches. 2. The Building Societies Association is a UK-wide body, with members in Scotland, England, Wales and Northern Ireland. It works from a single office in London. It views the banking market (broadly defined to include building societies) from a UK perspective and has no particular insights into the banking markets of England, Wales, Northern Ireland or, indeed, Scotland. The bulk of this evidence therefore covers the UK market, although references are made to the building society sector in Scotland. Accordingly, this evidence does not specifically answer the key questions posed by the Committee in a Scottish context. However, many of the points made in respect of the UK will have an impact on activity in Scotland in the same way as the other countries of the United Kingdom. Building Societies in Scotland 3. Until earlier this year, there were three building societies based in Scotland. Their total assets at the end of 2007, the latest year for which information is available, were as follows. Assets of Scottish Based Building Societies, End 2007, £ million Dunfermline 3,303 Scottish 259 (31 January 2008) Century 22 4. By 31 January 2009 the assets of the Scottish Building Society had grown to £296 million, by 31 December 2008 the assets of the Century Building Society had reached £24 million. As is well known, the Dunfermline Building Society did not distribute an annual report describing its financial position as at the end of 2008. This evidence does not dwell on circumstances leading to that situation. The Scottish Affairs Committee of the UK Parliament has published a comprehensive report on this matter that can be found at http://www.publications.parliament.uk/pa/cm200809/cmselect/cmscotaf/548/54802.ht m Brief History of Building Societies in Scotland 5. There had been just three building societies based in Scotland for a number of years. The Dunfermline Building Society had merged with, at least, nine other 1 Scottish societies since 1945, but the last of these (with the Edinburgh and Paisley Building Society) occurred in May 1981. The Scottish Building Society has absorbed 10 other societies since 1945; the last of these involved the transfer of engagements of the Huntly Building Society to the Scottish in November 1985. The Century Building Society has never been involved in merger activity. 6. Historically, the Scottish building society sector was relatively smaller than that in the rest of the United Kingdom. This has likely to have been the result of – (a) A relatively strong trustee savings bank movement in Scotland. Indeed, the TSBs were founded initially in Scotland, the first being established in 1810. (b) The historically, relatively low level of owner-occupation in Scotland. In recent years the level of owner-occupation in Scotland has grown rapidly; however in the pre and post war period it was much lower than in the rest of the United Kingdom, thus leading to a relatively low demand for mortgages in Scotland. In other words strong competition on the liability (savings) side of the balance sheet and a relative absence of demand on the asset (mortgage) side of the balance sheet led to relatively low levels of building society activity in Scotland. Unlike in the banking sector, that activity that did take place was dominated by English-based building societies in the final decades of the 20th century. As at the end of 2008, it is estimated that seven English-based societies operate in Scotland. Causes, Nature and Impact of the Boom and Recession The Boom 7. The extraordinary events of the last two years have tested the analytical powers of the most eminent and well informed economists, regulators, politicians, journalists and financiers. However, in the view of The Building Societies Association, the key elements of the financial crisis lay in the components of the boom conditions that existed in one form or another from the mid to late 1990s until mid 2007 – • A relaxation of credit underwriting standards • The development of a borrowing culture on the part of customers, institutions and Government • Firms moving away from their traditional businesses • Expectations of continued house price inflation • Over-extended funding lines, amidst expectations of continued large flows of cheap wholesale funding • A confusion of dispersion of risk with reduction of risk. In particular, securitisation allowed loan originators to remove risk from their balance sheets, without there being sufficient recognition that it ended up elsewhere in the system. • Unrecognised concentration risk • Lack of transparency in the packaging of certain wholesale instruments 2 • Pro-cyclical capital requirements – ie Basel II encouraged a reduction in capital holding in the run up to what emerged as recession. • Perverse incentives, particularly in the remuneration and bonus payment areas • Greed, arrogance and an over-emphasis on growth on the part of some institutions. 8. It is worth emphasising that these are characteristics observed across the market, not in every firm; many building societies (and a number of banks), for example, avoided most or all of the issues described above. 9. The bust from August 2007 was characterised by the unwinding of some of the attributes of the boom period itemised above. However, the bust also featured a range of other factors – (i) A rapid decline. 10. The rapidity of the change in economic and financial conditions took most by surprise. For example - • House prices fell by 20% in the first 18 months of the recession. In the 1990s there was a decline of this magnitude, but over four years. • Wholesale money markets “froze” from August 2007, with activity coming to a sudden halt, rather than conditions gradually deteriorating. • In late July 2007, the Northern Rock interim results for the first half of the year opened with an optimistic statement from the Chief Executive. Six weeks later depositors were queuing up to withdraw funds. This reflected the rapid deterioration in Northern Rock’s wholesale funding position. • Marking elements of the balance sheet to market probably transmitted changes within some poorly placed institutions more widely, more rapidly, to other institutions than expected. • Rating agencies were quick to alter their views on particular institutions. • New technology enabled information - and rumour - to be transmitted more rapidly, than in the past, between market participants. (ii) The Extent of the Crisis 11. Once the crisis had started it affected a far wider range of institutions and countries than anyone had anticipated. Indeed, the crisis showed that institutions, markets and countries had become integrated to a previously unrecognised extent. 12. Moreover, the extent of market punishment of institutions had no respect for the previous reputation, size, or nature of an institution. In the USA Fannie Mae and Freddie Mac, previously viewed as very solid, along with some of the greatest names in investment banking, failed to survive as independent entities. In the UK, what used to be called, in its building society days, the “Mighty Halifax” required Government assistance, as did the Royal Bank of Scotland, earlier believed to be an 3 outstanding success story. Despite their relatively good performance, mutuals were by no means immune to the crisis. (iii) Other Features 13. Other features of the bust part of the cycle included - • An unexpectedly strong link between declining share prices of institutions and depositor confidence in those institutions. • Forced withdrawal of mortgage lenders from the market. • Strong evidence of fraud. • A loss of trust and confidence both by institutions in each other, and retail depositors in institutions. • A growth in mortgage arrears and repossessions Government Assistance 14. In very brief summary, the main action on the part of Governments or central banks around the world consisted of the provision of – • Equity ie capital • Liquidity, including both enhanced central bank activity and quantitative easing • Guarantees • Low interest rates • Enhanced deposit protection • Help for specific markets. In the UK in the housing market, the price threshold for paying transactions tax (Stamp Duty) was increased, while various initiatives were introduced to help those with mortgage arrears. • The maintenance of government spending (often involving increased levels of borrowing) at a time of reduced economic activity • New legislation, particularly in the UK, to facilitate the orderly run down of failed institutions Building Societies – an Introduction 15. Building societies are a specific form of mutual entity established under UK legislation. They are not companies. Their legislation forces them to obtain the majority of their funding from the retail savings market, and to undertake the majority of their lending in the

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